3 Buys: Nike, Under Armour & Lululemon

Which is best for your portfolio? Let's take a close look at each

Nike

While speaking at the product launch of Nike’s FuelBand, which measures your wrist movement and overall activity, CEO Mark Parker indicated that Nike isn’t seeing a slowdown in any of its biggest markets. Fighting higher input costs with price increases, Parker expects incremental gross margin increases for the next several quarters into fiscal 2013. Nike has maintained consistently high margins over the years — both gross margins and operating margins. Since 2003, its gross margins have always been higher than 40%, and only once did operating margins drop below 10%.

Consistent margins translate into consistent profits. Investors can rest easy knowing that the Portland powerhouse will produce the goods. Since Nike does business globally, it’s always interesting to see where it’s going next. China continues to be a big priority for the company, with sales rising 35% in the second quarter, ended November 30, and now represent 11% of Nike’s overall sales. Considering that most of the world’s population growth, not to mention growth of the middle class, is happening in Asia, Nike’s numbers there will continue to grow for years to come.

My first concern with Nike is opposite of that for Under Armour in that Nike’s footwear business, which has lower margins than apparel, represents 64% of overall revenues. That’s not quite the imbalance found at Under Armour, but if Nike could move that closer to 50/50, its bottom line would look that much sweeter.

Second, there’s the Phil factor. What happens after Phil Knight retires? Even though Mark Parker is in charge now, Knight is still chairman and founder. Does the culture remain once he’s no longer around? It’s impossible to answer this, but it’s a concern nonetheless. Frankly, it’s tough to pinpoint any real weakness in Nike’s business.

Lululemon

This is the new kid on the block. Lululemon went public in July 2007 at a split-adjusted price of $9 a share. Since its IPO, the stock is up 568%, versus 92% for Nike and 44% for Under Armour. The company is most associated with yoga wear is doing a good job of expanding beyond its original market. Running apparel now accounts for one-fifth Lululemon’s overall sales, and cycling apparel looks to be the company’s next target.

While Lululemon designs great products, its retail stores are what drives its business. In the third quarter, ended October 31, 2011, same-store sales increased by 16% on a constant dollar basis. More impressive is that sales per square foot were $1,880 — higher than any other retailer in North America, with the possible exception of Tiffany & Co. (NYSE:TIF).

Although Canada is likely nearly saturated, with 45 stores, the U.S. has just 106. Since America’s population is 10 times Canada’s, there’s no telling where the expansion ends. That’s a good problem to have, especially with the kind of sales numbers each store generates. Finally, Lululemon now has five Ivviva stores in Canada, which cater to kids aged 6 to 12. Some suggest the U.S. could support as many as 50 of these stores. I suspect that number is conservative.

It’s hard to argue with a brand that’s been this successful. However, the biggest concern with Lululemon is growing too quickly and losing control of its business. You don’t generate
$1,880 in sales per square foot without enthusiastic brand evangelists. Getting sloppy and simply slapping up stores without paying attention to customer service and product quality will do nothing but turn off the faithful.

That’s something Lululemon has already faced in recent quarters as it deals with inventory issues. At different times in the past year, the company has had both inventory shortages and excesses as it tries to find the perfect balance. It likely never will.

The other issue, which all three of these companies face, is an imbalance in sales between the sexes. In Lululemon’s case, it’s a matter of not attracting enough male customers. But if that’s the worst problem the company has, it’s very lucky indeed.

The bottom line: All three of these companies have bright futures. Interestingly, each has high insider ownership. Is this a coincidence? I doubt it.

As of this writing, the author did not own a position in any of the stocks named here.